Some Federal Reserve members pushed for a rate hike at the Federal Open Market Committee’s (FOMC) most recent meeting.
The central bank stood pat, but the July meeting minutes show dissenting members said a hike “was or would soon be warranted, with a couple of them advocating an increase at [the July] meeting. [These] participants pointed out that various benchmarks for assessing the appropriate stance of monetary policy supported taking another step in removing policy accommodation.”
Further, those in favour of a hike pointed to the risk of “an unwanted buildup of inflation pressures,” which could lead to the Fed having to “rapidly increase” the federal funds rate.
These members also argued that “an extended period of low interest rates risked intensifying incentives for investors to reach for yield, [which] could lead to the misallocation of capital and mispricing of risk.”
The FOMC’s continued dovishness can mainly be blamed on inflation remaining below target, which was attributed to the weakness of oil prices and non-energy exports. Weak global growth is also a concern.
What’s noteworthy is that the “minutes met slightly hawkish expectations” and that “the committee was more divided than in the past” on how to proceed, says Prab Sagoo, associate director at Nasdaq Advisory Services.
Going forward, the Fed says it will decide whether a rate hike is needed based on “a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”
The minutes show the FOMC expects rates will remain low “for some time,” maintaining that any hikes will occur gradually.
But a September rate rise is “possible,” according to William Dudley, president of the Federal Reserve Bank of New York. In a television interview this week, he said he thought solid job growth would continue and that the sluggish pace of the U.S. economy would pick up.
Immediately following the release of the meeting minutes, CME Group’s FedWatch Tool indicated markets are now less sure of a September hike. At that time, nearly 90% predicted the central bank will stand pat, while 12% expected a hike. That compared to an 85%-15% split yesterday. More investors expect rates to rise in December.
Sagoo notes that the TSX gained 30 points in reaction and that U.S. indices were also higher. “Telco, REITS and utilities are moving higher as well as gold,” he adds. “Canadian government yields dropped, as did U.S. Treasuries, and the [loonie] strengthened slightly versus the USD.”
He concludes, “The possibility of near-term rate hike remains, but the latest release didn’t elaborate too much on future timing and markets discounted it a bit more.”
Next, investors will likely pay close attention to a speech Yellen’s giving on August 26 at an annual conference of central bankers in Wyoming.
Regarding the impact of the upcoming U.S. election, the Globe and Mail reports, “It isn’t uncommon for the central bank to take major policy action in presidential election years. In the past three decades, they have done so in every presidential election year, except [for in] 1996.”
Deep dive into the Fed’s findings
Looking at market activity between June 15 and July 27, the FOMC first discussed the impact of the U.K. referendum. Based on findings by Lorie Logan, deputy manager of System Open Market Account, the FOMC found that following the June 23rd vote, “yields on U.S. Treasury securities fell sharply [and] U.S. equity prices declined, [while] the foreign exchange value of the dollar increased.”
But, “these changes generally reversed in subsequent weeks: on balance, Treasury yields were down only slightly over the inter-meeting period, equity prices were higher, and the foreign exchange value of the dollar was little changed.”
The FOMC agreed to monitor the near-term effects of the U.K. referendum before making any further rate moves, but was generally more optimistic about global downside risk.
It also found U.S. growth prospects had improved, based on on stronger GDP and industrial numbers as well as modest improvement in the employment landscape.
What’s more, “Growth in real personal consumption expenditures (PCE) appeared to have picked up in the second quarter,” the FOMC minutes say. “Although sales of light motor vehicles declined in June, the average pace for the second quarter as a whole was essentially the same as in the first quarter. The apparent pickup in real PCE growth was consistent with […] continued gains in real disposable personal income and in households’ net worth. Also, consumer sentiment […] remained reasonably upbeat in the second quarter and in early July.”
Still, there are some domestic challenges, the minutes adds, when you consider the recovery of the U.S. housing sector, the slow pick-up in business spending and the lower-than-desired number of oil rigs in operation (an indicator of spending for structures in the drilling and mining sector).
So the FOMC left its forecast for real GDP in 2017 and 2018 little changed. The minutes say, “The projected step-up in real GDP growth over the second half of this year was marked down a little, partly reflecting softer news on construction […] The positive effects of a slightly lower assumed path for interest rates and a stronger trajectory for household wealth were mostly offset by the restraint from a weaker outlook for foreign GDP growth and a slightly stronger path for the foreign exchange value of the dollar.”
The upside is the FOMC continues “to forecast that real GDP [will] expand at a modestly faster pace than potential output in 2016 through 2018, supported primarily by increases in consumer spending.” Further, “the unemployment rate [is] expected to remain flat over the second half of this year, and then to gradually decline through the end of 2018.”